Many small organizations we talk to want to know more about the tax deductibility of medical premiums. This article discusses when medical premiums are eligible pre-tax as opposed to after-tax.
What are Pre-Tax Medical Premiums?
A pre-tax medical premium is deducted from the employee’s pay before any income taxes or payroll taxes are withheld and then paid to the insurance company. This can deliver savings of up to 40%, depending on your tax bracket. Pre-tax premiums are typically employer-sponsored plans and include the following:
- Major medical coverage purchased through your employer
- Supplemental/voluntary coverage purchased through your employer
- Healthcare spending account contributions, such as FSAs
- Employer-sponsored reimbursements for medical premiums (see below)
After-Tax Medical Premiums
If you do not want to participate in your employer’s pre-tax plan, or if your employer doesn’t offer a pre-tax plan, you can elect to deduct your medical premiums on an after-tax basis. After-tax premiums include the following:
- Major medical coverage purchased on your own (for example, purchasing individual health insurance through the Health Insurance Marketplace).
- Supplemental/voluntary coverage purchased on your own.
One reason you might do this is if you expect you will want to drop coverage and enroll in another plan in the middle of the year. Coverage paid with after-tax dollars can be dropped at any time and enrolling and you will not have to wait for enrollment periods to sign up for another plan.
Tax deductions for after-tax premiums
After-tax plans can still offer some savings. You can still list premiums as an itemized deduction on Schedule A when you file your income taxes, for all medical expenses and premiums that exceed 7.5% of your income. Additionally, most self-employed taxpayers (including owners) can deduct health insurance premiums using Schedule 1 for Line 16 on their tax form 1040.
HRAs deliver pre-tax benefits with after-tax flexibility
As mentioned above, reimbursements for premiums are considered pre-tax, but function a bit differently than other pre-tax plans.
With a health reimbursement arrangement (HRA), you purchase a plan on the individual insurance exchange using after-tax dollars. Your employer then reimburses you for premiums, and often other out-of-pocket medical expenses, up to an employer-defined amount (this is typically a monthly or annual “allowance”). The reimbursements are made on a pre-tax basis, so you get the same payroll and income tax benefits as you would with a traditional pre-tax plan.
In addition, you also get the benefits of an after-tax plan. You choose the exact plan you want and need, typically from a much larger set of carriers and offerings than your employer might offer. You can drop the plan at any time and you can take it with you if you leave your employer. (If you leave the employer, you will lose the pre-tax reimbursements.)
If your employer sponsors an insurance plan, you will be able to pay for premiums on a pre-tax basis, which will save you income taxes and payroll taxes. If you purchase a plan on your own, you will have much more flexibility but will pay more in taxes. If your employer uses an HRA, you can get the best of both worlds.
This article was originally published June 9, 2015. It was last updated November 6, 2020.